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January Market Update 2021

Luke Sheather
Luke Sheather
Posted 05.02.2021 in Industry Updates
This January Market Update looks at how after a positive start to the year, we saw share markets give up their early gains in what was a highly volatile end of the month.

Growing uncertainty around the deployment of vaccines combined with the fallout from the Reddit-GameStop saga weighed down returns in developed markets, including Australia.

However, we did see Emerging Markets enjoy another strong month. As countries such as China, Korea and Taiwan (who together make up approximately two-thirds of the emerging share market) continue to lead the charge in their economic recoveries, following their superior handling of COVID-19.

We also saw bond returns fall slightly after 10-year Treasury yields surpassed 1% for the first time since March. The lift in yields was a consequence of the market expecting improved growth, as well as the prospect of additional fiscal stimulus in the US.

Australia trending in the right direction

The Australian market was encouraged by better than expected inflation and employment figures last month. RBA Governor, Philip Lowe also stated that the economic recovery was playing out faster than what was initially anticipated and that GDP was now expected to return to its pre-pandemic level by mid-2021. All very positive! However, this hopeful outlook is largely dependent on a successful vaccine rollout, which is set to commence in February.

The Blue Wave

It might be a new year, but US politics still dominated the headlines in January. The storming of the Capitol Building during the certification of Joe Biden’s victory was a disturbing low point. Although perhaps of greater significance, at least from a market perspective, was the shock result out of Georgia, where the Democrats won both available seats in the crucial run-off elections, effectively giving them control of the Senate.

This result has massive implications for Joe Biden’s legislative ambitions and now gives him greater scope to push ahead with his policy agenda. Wasting little time, Biden has already proposed a 1.9 trillion-dollar American Rescue Plan, designed to boost the economy until the COVID-19 vaccine is widely available.

It’s also expected that he will eventually push for higher taxes, on both companies and high-income earners, greater anti-trust regulation in the dominant tech space and stronger action in relation to climate control. While each of these measures are likely to have a significant impact across various sectors, the markets primary focus to date has been on the stimulus package and the anticipated shift to a greener economy.

Reddit Warriors

The Reddit sub-channel “WallStreetBets” gained a remarkable amount of attention last month. The six-million-strong community-directed buying into numerous unloved US companies that had been heavily shorted (or backed to decrease in value) by several large hedge funds.

The herding tactics proved successful, initially, as the prices for companies such as GameStop skyrocketed. Volumes and volatility also surged, and multiple trading platforms were forced to impose trading limits on certain securities.

While there will always be a gravitational pull towards opportunistic “get-rich-quick” strategies, such as these, it’s important to acknowledge that such investments are highly speculative, rarely involve much fundamental sense and are often short-lived. At the time of writing, GameStop had already fallen 85% from its peak last month.

Share market valuations

Another topic that’s been widely discussed in various January market updates is the possibility of an imminent pullback in the share market. The extended rally following the March COVID-19 lows has driven traditional valuation measures, like the price to earnings ratio, to well above average levels. Generating fresh concerns that the share market has become overvalued or expensive.

However, when we’re comparing company valuations over different time periods, it’s important we consider them in the context of what the prevailing market conditions were like at that point in time. Particularly interest rates conditions, which can have a material effect on the valuation of a company.

The yield gap is a measure that’s often used to better understand company valuations in varying interest rate environments. It simply compares the earnings yield available from owning shares, to the yield available from owning 10-year treasury bonds.

Yield Gap  Corporate Earnings Yield  less  Yield on 10yr Gov’t Bonds.

Over time we expect this premium to be reasonably consistent. An above-average yield gap tells us that shares are relatively cheap, considering interest rate conditions. While a below-average reading suggests that shares are relatively expensive.

Observing the yield gap in Australia and the US over the last twenty years, we can see that both markets are currently just above their average of 2.5%. This would suggest that share valuations today may still be appropriate, given the current interest rate and bond yield environment. However, if we continue to see bond yields increase, as they did in January, it will certainly put pressure on valuations in the upcoming months.

Outlook

The “recovery” story will continue to drive markets in 2021. Yet, given the market has likely priced in most of the optimism, any unforeseen obstacles that threaten progress will probably see share markets retreat. In managing the uncertainty, investors can best prepare themselves by remaining diversified across investments that will both benefit from a cyclical expansion, as well as provide defensive characteristics in times of market duress.

If you enjoyed this January Market update, you can watch our February update here. 

Luke Sheather
Luke Sheather
Luke Sheather
As Capital Partners Investment Specialist, Luke does far more than simply identifying and recommending investments, Luke sees it as his role to help clients contemplate and answer life’s big questions.

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